One of the most overlooked areas in a private equity transaction is a due diligence background investigation on the key players or principals part of the transaction. The purpose of the due diligence background investigation is to evaluate the integrity of individuals – both personally and professionally – that you are going to be doing business with. Understanding the personal and professional history of those key players can be the difference between a successful transaction and a complete failure.
People are Assets
In some cases, the key assets that are being acquired as part of an acquisition are hard assets such as a product, factory, patent or even an idea. But in other cases, the most important assets are the people that are going to be on board, especially in service related businesses. If the transaction involves the acquisition of key principals that are going to be the foundation to the future success of the company, among the key issues that need to be answered as part of the due diligence investigation process is the background and reputations of the parties whom you will be doing business with.
Key issues that could be uncovered:
- Business Interests – Corporate executives engaging in self-dealing or previous business interests that have been the subject of controversy, bankruptcy or sanctions
- Personal History – Multiple divorce filings with allegations of personal misconduct
- Professional History – Falsified education credentials or misrepresentations of previous work history
- Regulatory Issues – Undisclosed regulatory complaints or disciplinary actions taken by state or federal regulatory agency
- Criminal/Civil Cases – Multiple convictions for driving under the influence of alcohol, allegations of soliciting a prostitute or litigious past
- Financial Status – Hundreds of thousands of dollars in federal tax liens, credit issues to grievances filed with U.S. Tax Court
- Assets – Multiple houses and boats which could show someone living beyond their means
Who should a private equity firm conduct a due diligence background investigation on?
To best answer this question, some of the key questions that you need to ask yourself is: how much capital is at risk, how much reliance is being placed on the key principals of this transaction and the nature of the business (a paper mill and an oil exploration business have two totally different risk profiles). Ultimately, it’s a choice that the private equity firm must make, but at the very least, a due diligence background investigation should be conducted on the key principals as part of the transaction, specifically those individuals whom you have identified during the transaction as keys to the future success to the company.
Having the wrong management in charge can be the difference between an immediately successful acquisition or a complete failure. The goal of the due diligence background investigation is to identify relevant issues in management’s background and track record to make a well informed business decision that could impact your investment decision.